IHH is buying Fortis for INR170/share via a combination of fresh equity injection and secondary purchase from public shareholders for a cash consideration of RM2.3b-RM4.3b. We are neutral on this corporate development by IHH. The deal is positive because it propels IHH to become a leading PanIndian hospital operator. However, we are concerned about execution risk at Fortis. No changes to our earnings forecasts for now. Reiterate UP. TP is RM5.10 based on SoP valuation.

Proposal to buy Fortis for INR170/share. In an announcement to Bursa Malaysia, IHH, via wholly-owned Northern TK Venture Pte. Ltd. (“Northern TK”), was announced as the preferred bidder to acquire a controlling stake in Fortis Healthcare Limited (Fortis), via a combination of primary equity injection (subscription of 235.3m new Fortis shares) and secondary purchase from public shareholders of Fortis Healthcare at an offer price of INR170/share (RM9.93/share) or 19.5% higher than the closing price in 12 July 2018. Upon completion of the Fortis acquisition, IHH will hold at least 31.1% stake and a maximum of 57.1% equity stake in Fortis on a fully diluted basis after the preferential allotment and simultaneously triggering a mandatory offer to acquire 26% equity stake in Fortis Healthcare’s listed subsidiary, Fortis Malar Hospital Limited for RM17m. The preferential allotment will make IHH the largest shareholder in Fortis with 31.1% stake and would trigger a mandatory general offer to the public shareholders of Fortis Healthcare for 26% of the outstanding shares. The proposals are expected to be completed in 4Q18.

Impact to financials. Based on the offer price of INR170/share, the implied equity valuation for 100% of Fortis is INR88.8b (RM5.2b). The offer price works out to EV/EBITDA of 22.3x based on Fortis’ FYE Mar 18 EBITDA. In terms of PER, the consideration of RM2.35b or 31.1% stake offer works out to a PER of 73x CY19E consensus net profit of RM103.4m. The acquisition appears expensive compared to regional hospital providers trading at an average of 35-40x PER. However, to acquire a strategic controlling stake, the acquisition PER was expected to command a premium to regional peers. The proposed acquisition of Fortis is expected to be earnings dilutive in the short to medium term but should gradually be earnings accretive once operations ramp up. For illustrative purposes, i) based on Fortis’ consensus estimates, IHH’s FY19E EPS is expected to be diluted by 2% and 4% assuming 31% and 57% Fortis stakes, respectively (please see table overleaf); ii) based-on-our-back of envelope calculation our SOP valuation is expected to raise the TP from RM5.10 to RM5.25. The total funding required for the transaction will be between INR40b (RM2.35b) and INR74b (RM4.33b), which will be funded through existing cash reserves and debt facilities. The acquisition is expected to raise IHH’s net gearing to 15% from 4% as at 31 Mar 2018.

Fortis posed execution risk. We are neutral on this corporate development by IHH. The deal is positive because it propels IHH to become a leading Pan-Indian hospital operator, operating more than 5,400 beds in 37 hospitals. However, we are concerned about issues at Fortis, including an auditor’s qualified audit report in FY18, risk of more provisions, lapses in internal controls, which led to regulatory probing, which could well mean execution risk.

Maintain UNDERPERFORM. We maintain our earnings forecasts for now and sum-of-parts (SoP) TP of RM5.10.

Key upside risk to our call: faster-than-expected ramp up in new hospitals.

Source: Kenanga Research - 16 Jul 2018